Gaurav Saroliya is 24 years old and hails from Jaipur and is an Economics scholar at the Centre for Development Studies, Trivandrum where he is in the process of finishing his MPhil research. He has three years' work experience as an editor for an organisation called the Research Development Association, Jaipur, which publishes journals like Journal of Accounting and Finance and Management Persepectives. Besides that he has taught French at Alliance Francaise and has alos worked on a UNDP project on behavioural reforms in the police for one year. He has sent us his views on our CEO's letter of October 2002 to the Hon'ble Finance Minister. But before that he comments on the reduction of interest rates by the Fed in the US.

Argument :- "When interest payments are near zero nobody feels the need to restructure clumsy operations and excess indebtedness. When interest rates are extremely low and equity returns negative, how can financial markets efficiently allocate capital? Break the navigator's compass and nobody knows which way is north. Very low interest rates artificially inflate certain economic sectors. We do not agree that the best way to jump-start the world economy is to lower interest rates. Perhaps the worst effect is on the household savings rate. The Japanese example shows us that when households cannot get a decent return on savings, they just save more to reach a level of capital deemed necessary for financial security and retirement needs. America has not gone this way yet because households believed until recently that the economy was in a temporary slowdown. Soon, this will change and the savings rate must increase above the historical average, bringing with it a nasty surprise."

Gaurav responds : - There are several problems with the above argument. For one thing, it assumes that firms feel the need to restructure clumsy operations only in the face of financial pressure, typically generated by a large amount of interest payments relative to the cash flows of the firm. But recent empirical research in an agency-cum-endogenous-growth context has shown that there are several other significant factors that affect managerial/worker incentives to restructure, adapt and perform. Examples include Stephen Nickell’s recent studies on the British economy published in the European Economic Review, 1992 and 1997, and Journal of Political Economy, 1996 and another by two German economists in the context of post-unification Germany. These other factors may include greater product market competition or the presence of a dominant external shareholder who monitors the firm’s actions from outside or a high specificity of assets.

Secondly, financial markets are an efficient means of allocating resources only in those industrially advanced and developed economies where they are well developed. They may have little or no role in resource allocation in, for example, a relatively socialist set-up where the state performs the resource allocation function.

Thirdly, the argument seeks to generalise on very limited premises. The Japanese example quoted above is quite a pathological case. Japan, like the United States, is an overwhelmingly consumption driven economy. 60% of the Japanese and about 65% of the US GDP are contributed to by consumer spending. Although the US economy has shown laudable robustness and resilience through the 90’s, it must be recognised that such economies are extremely susceptible to vicious cycles of the sort Japan has been caught in over the entire decade of nineties. Once there is a downturn, the central bank cuts the interest rate to spur demand which has, besides a prodding effect on demand, a dampening effect on savings too. The latter effect in the extreme case could lead to the sort of over-saving referred to above and have adverse consequences for consumer demand and GDP growth. But by no stretch of imagination is this a universal phenomenon, unless of course the economy is question is as consumption-dependent as the Japanese. The speculation about the US economy is also pretty groundless. The argument provides no statistics regarding any recent expansive household saving behaviour. Nor are their any hard facts suggesting strongly that the economic downturn promises to be persistent, though strength to such a notion may be added by incidents like September 11. So the “nasty surprise” anticipated soon may not be a very probable outcome after all.

Lastly, there is no “best way” to jump-start the world economy. A national economy is an extremely complex reality. The world economy is even more complex. Each constituent economy of the world economy has its own peculiarities. Some are largely consumption driven like those referred to above. But others may have a relatively large share of, for example, government spending or investment or even trade as in the case of Singapore. So whereas an interest-rate cut may work in one economy, it might be the Keynesian government expenditure that could provide more effective solutions in another. Thus, while tackling problems of demand and output growth in the world economy, it’s not sensible to look for general solutions. Of course, if one goes by the notion of “ if the US sneezes, the world catches a cold,” then one must concentrate on US growth only, as a significant fraction of the remainder of the world economy depends on the former for its trade.

Gaurav comments on the letter to the Hon'ble Finance Minister :-

You seek to call RBI's low interest rate policy into question, but I am afraid not for the best reasons. Does India suffer from a downturn caused by excessive investment through heavy borrowing? I too don't have a definitive answer. But my hunch is that it doesn't.

I have a couple of comments regarding your observation that interest rate cuts haven't resulted in a spurt in investment activity. Firstly, low interest rates haven't spurred investment demand not because they were low. There are other reasons. For one thing, the real interest rate has been pretty high, especially after Manmohan Singh's time as FM. One may recall that inflation has stayed low in the latter half of the nineties starting from Chidambaram's tenure. Secondly, despite the lowering of the reference rates by the RBI, the spreads of banks and lending agencies have been too small to allow of any significant PLR cuts. This is mainly on account of high transaction costs and NPA's and not because of a low-interest rate policy of the central bank. However, in spite of my belief in a low-interest-rate-low-inflation regime, I must concede the point that relentless rate cuts are likely to have an adverse impact on savings, especially through cuts in small-saving rates. Moreover, it is also noteworthy that private savings have been stagnant over the nineties and public savings have actually been falling over the same period. So there might be substantial merit in your argument on this account.

You have my unqualified support on the point you have made about the non-listed MNC's. Despite provisions such as the local-content and export obligation clauses, absence of listing still suggests a lack of credible commitment to the Indian market. Secondly, as you observe, being non-listed, such subsidiaries can effectively cause a wealth-drain from India which a veritably avoidable prospect. Thirdly, wealth creation by shareholding, apart from salaries and bonuses, also becomes highly advisable on this account. Moreover, ownership share of employees, as in the agency literature, may sharpen the worker incentives to perform better, which will have desirable productivity consequences. The IPR argument is curious. I gave it hard thinking. I too don't know how non-listing helps IPR protection.

Your suggestion regarding MNC's playing a major role in achieving the annual job-creation target of 15 million sounds plausible but not very feasible at least in the immediate future. I ascribe this to the institutional deterrents to greater MNC activity in India which may take a long time to go. These may include poor infrastructure, unfavourable legal framework governing business and other "regulatory obstacles" by the state. These problems may not be remedied in a very short time. Besides resources, it also requires consensus among various interest groups (political, business, etc) and lobbies to implement significant policy changes. However, the vision and intent are still noble and, if implemented, could be highly beneficial.

Your concern on low penetration of securities markets is a legitimate one. If stock market has to be the engine of growth, especially by facilitating finance for innovation, then it must have significant depth which, to all intents and purposes, it doesn't have in India at the moment. This will need significant reform at the level of regulation as well as transaction. The "capital market culture" may not flourish for want of enough investor awareness and transparency in dealing. To broaden the base of shareholding, proactive investor education may be necessary so that more and more individuals may invest and dilute the concentration of holdings in the hands of few institutional investors that are primarily responsible for market instability. Admittedly, not many people understand the subtle intricacies of stock-market dealing. You are right about the role of shareholding concentration in inducing unethical business behaviour.

Regarding your observation on scientific research, one need not look at any statistics. That the condition of scientific research is pathetic in India is common knowledge. But more worrisome than that is our inability to retain our skilled manpower. The continual exodus of trained scientists and other professionals to developed countries does not bode well for the future of technical progress in India. There is an urgent need to stem the tide of this trend. The well-known reason is lack of enough incentives and opportunities.

Lastly, the dividend tax which is quite a vexatious issue is, in my view, a pure and simple case of double taxation. It's hard to overstate the need for its abolition.

(Note : We do not know nor have we ever met Gaurav Saroliya in person. He has communicated with us through the web only. Any persons relying on what is stated hereinabove must do so at their risks to costs and consequences and we at Bee Management assume no responsibility.)